Chapter 21 Budgeting Accounting, 21st Edition Warren Reeve Fess © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc. PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

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After studying this chapter, you should be able to: Objectives 1. Describe budgeting, its objectives, and its impact on human behavior. 2. Describe the basic elements of the budget process, the two major types of budgeting, and the use of computers in budgeting. 3. Describe the master budget for a manufacturing business. 4. Prepare the basic income statement budgets for a manufacturing business. 5. Prepare balance sheet budgets for a manufacturing business. After studying this chapter, you should be able to:

Nature and Objectives of Budgeting Estimated portion of your total monthly income that should be budgeted

Nature and Objectives of Budgeting Establishing specific goals Executing plans to achieve the goals Periodically comparing actual results to the goals Feedback PLANNING DIRECTING CONTROLLING

Nature and Objectives of Budgeting Human Behavior and Budgeting Setting budget goals too tightly Setting budget goals too loosely Setting conflicting budget goals

Nature and Objectives of Budgeting Goal conflict occurs when individual self-interest differs from business objectives. A student’s question, “Will this be on the test?” is evidence of goal conflict.

Continuous Budgeting One-Year Budget Delete on February 28 Feb. 2006 Mar. 2006 Apr. 2006 May 2006 June 2006 July 2998 Aug. 2006 Sep. 2006 Oct. 2006 Nov. 2006 Dec. 2006 Jan. 2007 Delete on February 28

Continuous Budgeting One-Year Budget Add February 2007 Mar. 2006 Apr. 2006 May 2006 June 2006 July 2998 Aug. 2006 Sep. 2006 Oct. 2006 Nov. 2006 Dec. 2006 Jan. 2007 Feb. 2007 Add February 2007

Static Budgets Description: A budget that does not reflect potential changes in volume or activity level Strength: It is simple—all expenses are budgeted as fixed costs Weakness: It does not reflect changes in revenues and expenses that occur as volumes change Typical usage: Service organizations or administrative departments of retailers and manufacturers

Static Budgets Electric Power 5,000 Supervisor salaries 15,000 Colter Manufacturing Company Assembly Department Budget For the Month Ending July 31, 2006 Direct labor $40,000 Electric Power 5,000 Supervisor salaries 15,000 Total department costs $60,000

Flexible Budgets Description: A budget that shows revenues and expenses for a variety of volumes or activity levels Strength: Provides information needed to analyze the impact of volume changes on actual operating results Weakness: Requires greater research into costs—must differentiate fixed and variable costs Typical usage: Operational departments of retailers and manufacturers whose costs change with sales and production

Cost per unit is $5.50 at all levels of activity Colter Manufacturing Company Assembly Department Budget For the Month Ending July 31, 2006 Units of production 8,000 9,000 10,000 Variable cost: Direct labor $40,000 $45,000 $50,000 Electric power 4,000 4,500 5,000 Total variable cost $44,000 $49,500 $55,000 Cost per unit is $5.50 at all levels of activity

Colter Manufacturing Company Assembly Department Budget For the Month Ending July 31, 2006 Units of production 8,000 9,000 10,000 Variable cost: Direct labor $40,000 $45,000 $50,000 Electric power 4,000 4,500 5,000 Total variable cost $44,000 $49,500 $55,000 Fixed cost: Electric power $ 1,000 $ 1,000 $ 1,000 Supervisor salaries 15,000 15,000 15,000 Total fixed cost $16,000 $16,000 $16,000

Colter Manufacturing Company Assembly Department Budget For the Month Ending July 31, 2006 Units of production 8,000 9,000 10,000 Variable cost: Direct labor $40,000 $45,000 $50,000 Electric power 4,000 4,500 5,000 Total variable cost $44,000 $49,500 $55,000 Fixed cost: Electric power $ 1,000 $ 1,000 $ 1,000 Supervisor salaries 15,000 15,000 15,000 Total fixed cost $16,000 $16,000 $16,000 Total department costs $60,000 $65,500 $71,000

Static and Flexible Budgets Overbudget Static Budget Actual Results $60,000 $72,000

Static and Flexible Budgets Overbudget 10,000 units 9,000 units 8,000 units Actual Results Flexible Budget $60,000 $65,500 $71,000 $72,000

Budgeted Income Statement Budgeted Balance Sheet Master Budget Budgeted Income Statement Budgeted Balance Sheet Sales budget Cost of goods sold budget: Production budget Direct materials purchases budget Direct labor cost budget Selling and administrative expense budget Cash budget Capital expenditure budget

Income Statement Budgets

+ Desired units in ending inventory Sales Budget Production Budget Expected units of sales + Desired units in ending inventory – Estimated units in beginning inventory Total units to be produced

– Est. beginning materials inventory Sales Budget Production Budget Direct Materials Purchases Budget Materials needed for production + Desired ending materials inventory – Est. beginning materials inventory Direct materials to be purchased

Selling & Administrative Sales Budget Production Budget Direct Materials Purchases Budget Cost of Goods Sold Budget Direct Labor Cost Budget Selling & Administrative Expenses Budget Factory Overhead Cost Budget

For the Year Ending December 31, 2006 Elite Accessories Inc. Sales Budget For the Year Ending December 31, 2006 Unit Sales Unit Selling Total Product and Region Volume Price Sales Wallet: East……………….. 287,000 $12.00 $ 3,444,000 West………………. 241,000 12.00 2,892,000 Total……………. 528,000 $ 6,336,000 Handbag: East……………….. 156,400 $25.00 $ 3,910,000 West………………. 123,600 25.00 3,090,000 Total……………. 280,000 $ 7,000,000 Total revenue from Sales……………….. $13,336,000

For the Year Ending December 31, 2006 Elite Accessories Inc. Production Budget For the Year Ending December 31, 2006 Units Wallet Handbag Expected units to be sold 528,000 280,000 From sales budget

For the Year Ending December 31, 2006 Elite Accessories Inc. Production Budget For the Year Ending December 31, 2006 Units Wallet Handbag Expected units to be sold………….528,000 280,000 Plus desired ending inventory, December 31, 2006……………. 80,000 60,000 Total 608,000 340,000

For the Year Ending December 31, 2006 Elite Accessories Inc. Production Budget For the Year Ending December 31, 2006 Units Wallet Handbag Expected units to be sold…………. 528,000 280,000 Plus desired ending inventory, December 31, 2006……………. 80,000 60,000 Total………………………………. 608,000 340,000 Less estimated beginning inventory, January 1, 2006…………………. 88,000 48,000 Total units to be produced………… 520,000 292,000

Direct Materials Purchases Budget Elite Accessories Inc. Direct Materials Purchases Budget For the Year Ending December 31, 2006 Direct Materials Leather Lining Total Square yards required for production: Wallet (Note A)………………….. 156,000 52,000 Note A: Leather: 520,000 units x 0.30 sq. yd. per unit = 156,000 sq. yds. Lining: 520,000 units x 0.10 sq. yd. Per unit = 52,000 sq. yds.

Direct Materials Purchases Budget Elite Accessories Inc. Direct Materials Purchases Budget For the Year Ending December 31, 2006 Direct Materials Leather Lining Total Square yards required for production: Wallet (Note A)……..……..…….. 156,000 52,000 Handbag (Note B)……………….. 365,000 146,000 Note B: Leather: 292,000 units x 1.25 sq. yd. per unit = 365,000 sq. yds. Lining: 292,000 units x 0.50 sq. yd. Per unit = 146,000 sq. yds.

Direct Materials Purchases Budget Elite Accessories Inc. Direct Materials Purchases Budget For the Year Ending December 31, 2006 Direct Materials Leather Lining Total Square yards required for production: Wallet (Note A)……....………….. 156,000 52,000 Handbag (Note B).………………. 365,000 146,000 Plus desired inventory, Dec. 31, 2006 20,000 12,000 Total……………………………… 541,000 210,000

Direct Materials Purchases Budget Elite Accessories Inc. Direct Materials Purchases Budget For the Year Ending December 31, 2006 Direct Materials Leather Lining Total Square yards required for production: Wallet (Note A) …………………. 156,000 52,000 Handbag (Note B) ………………. 365,000 146,000 Plus desired inventory, Dec. 31, 2006 20,000 12,000 Total……………………………… 541,000 210,000 Less estimated inventory, Jan. 1, 2006 18,000 15,000 Total square yards to be produced.. 523,000 195,000

Direct Materials Purchases Budget Elite Accessories Inc. Direct Materials Purchases Budget For the Year Ending December 31, 2006 Direct Materials Leather Lining Total Square yards required for production: Wallet (Note A)………………….. 156,000 52,000 Handbag (Note B).………………. 365,000 146,000 Plus desired inventory, Dec. 31, 2006 20,000 12,000 Total……………………………… 541,000 210,000 Less estimated inventory, Jan. 1, 2006 18,000 15,000 Total square yards to be produced.. 523,000 195,000 Unit price (per square yard)…………. x $4.50 x $1.20 Total direct materials to be purchased. $2,353,500 $234,000 $2,587,500

Direct Labor Cost Budget For the Year Ending December 31, 2006 Elite Accessories Inc. Direct Labor Cost Budget For the Year Ending December 31, 2006 Cutting Sewing Total Hours required for production: Wallet (Note A)…………. 52,000 130,000 Note A: Cutting Department: 520,000 units x 0.10 hr. per unit = 52,000 hrs. Sewing Department: 520,000 units x 0.25 hr. per unit = 130,000 hrs.

Direct Labor Cost Budget For the Year Ending December 31, 2006 Elite Accessories Inc. Direct Labor Cost Budget For the Year Ending December 31, 2006 Cutting Sewing Total Hours required for production: Wallet (Note A)…………. 52,000 130,000 Handbag (Note B)……….. 43,800 116,800 Note A: Cutting Department: 520,000 units x 0.10 hr. per unit = 52,000 hrs. Sewing Department: 520,000 units x 0.25 hr. per unit = 130,000 hrs. . Note B: Cutting Department: 292,000 units x 0.15 hr. per unit = 43,800 hrs. Sewing Department: 292,000 units x 0.40 hr. per unit = 116,800 hrs

Direct Labor Cost Budget For the Year Ending December 31, 2006 Elite Accessories Inc. Direct Labor Cost Budget For the Year Ending December 31, 2006 Cutting Sewing Total Hours required for production: Wallet (Note A)…………. 52,000 130,000 Handbag (Note B)……….. 43,800 116,800 Total……………………... 95,800 246,800 Note A: Cutting Department: 520,000 units x 0.10 hr. per unit = 52,000 hrs. Sewing Department: 520,000 units x 0.25 hr. per unit = 130,000 hrs. . Note B: Cutting Department: 520,000 units x 0.15 hr. per unit = 43,800 hrs. Sewing Department: 520,000 units x 0.40 hr. per unit = 116,800 hrs

Direct Labor Cost Budget For the Year Ending December 31, 2006 Elite Accessories Inc. Direct Labor Cost Budget For the Year Ending December 31, 2006 Cutting Sewing Total Hours required for production: Wallet (Note A)…………. 52,000 130,000 Handbag (Note B)……….. 43,800 116,800 Total……………………... 95,800 246,800 Hourly rate…………………… x $12.00 x $15.00 Total direct labor cost………… $1,149,600 $3,702,000 $4,851,600 Note A: Cutting Department: 520,000 units x 0.10 hr. per unit = 52,000 hrs. Sewing Department: 520,000 units x 0.25 hr. per unit = 130,000 hrs. Note B: Cutting Department: 520,000 units x 0.15 hr. per unit = 43,800 hrs. Sewing Department: 520,000 units x 0.40 hr. per unit = 116,800 hrs

Factory Overhead Cost Budget For the Year Ending December 31, 2006 Elite Accessories Inc. Factory Overhead Cost Budget For the Year Ending December 31, 2006 Indirect factory wages……………………... $ 732,800 Supervisory salaries………………………... 360,000 Power and light…………………………….. 306,000 Depreciation of plant and equipment………. 288,000 Indirect materials…………………………… 182,800 Maintenance………………………………... 140,280 Insurance and property taxes………………. 79,200 Total factory overhead cost………………... $2,089,080

Cost of Goods Sold Budget For the Year Ending December 31, 2006 Elite Accessories Inc. Cost of Goods Sold Budget For the Year Ending December 31, 2006 Finished goods inventory, January 1 ,2006….. $ 1,095,600 Work in process inventory, January 1, 2006… $ 214,400 Direct materials: Direct materials inventory, January 1, 2006 (Note A)…………………………………. $ 99,000 Note A: Leather: 18,000 sq. yds. x $4.50 per sq. yd $81,000 Lining: 15,000 sq. yds. x $1.20 per sq. yd 18,000 Direct materials inventory, January 1, 2006 $99,000

Cost of Goods Sold Budget For the Year Ending December 31, 2006 Elite Accessories Inc. Cost of Goods Sold Budget For the Year Ending December 31, 2006 Finished goods inventory, January 1 ,2006….. $ 1,095,600 Work in process inventory, January 1, 2006… $ 214,400 Direct materials: Direct materials inventory, January 1, 2006 (Note A)…………………………………. $ 99,000 Note B: Leather: 20,000 sq. yds. x $4.50 per sq. yd $ 90,000 Lining: 12,000 sq. yds. x $1.20 per sq. yd 14,400 Direct materials inventory, December 31, 2006 $104,400

Cost of Goods Sold Budget For the Year Ending December 31, 2006 Elite Accessories Inc. Cost of Goods Sold Budget For the Year Ending December 31, 2006 Finished goods inventory, January 1 ,2006…. $ 1,095,600 Work in process inventory, January 1, 2006... $ 214,400 Direct materials: Direct materials inventory, January 1, 2006 (Note A)…………………………………. $ 99,000 Direct materials purchases (Slide 3)…….. 2,587,500 Cost of direct materials available for use…. $2,686,500 Less direct materials inventory, December 31, 2006 (Note B)……………. 104,400 Cost of direct materials placed in production $2,582,100 Direct labor (Slide 35)………………………. 4,851,600 Factory overhead (Slide 36)………………….. 2,089,080 Total manufacturing costs……………………. 9,522,780 Total work in process during period…………. $9,737,180

Cost of Goods Sold Budget For the Year Ending December 31, 2006 Elite Accessories Inc. Cost of Goods Sold Budget For the Year Ending December 31, 2006 Finished goods inventory, January 1 ,2006………... $ 1,095,600 Work in process inventory, January 1, 2006……….. $ 214,500 Total manufacturing costs………………………….. 9,522,780 Total work in process during period……………….. $9,737,180 Less work in process inventory, December 31, 2006 220,000 Cost of goods manufactured………………………... 9,517,180 Cost of finished goods available for sale…………... $10,612,780 Less finished goods inventory, December 31, 2006.. 1,565,000 Cost of goods sold………………………………….. $ 9,047,780

Selling and Administrative Expenses Budget Elite Accessories Inc. Selling and Administrative Expenses Budget For the Year Ending December 31, 2006 Selling expenses: Sales salaries expense…………………………. $715,000 Advertising expense…………………………... 360,000 Travel expense…………………………………. 115,000 Total selling expenses………………………... $1,190,000 Administrative expenses: Officers’ salaries expense………………………. $360,000 Office salaries expense…………………………. 258,000 Office rent expense……………………………... 34,500 Office supplies expense…………………………. 17,500 Miscellaneous administrative expense………….. 25,000 Total administrative expenses………………… 695,000 Total selling and administrative expenses………… $1,885,000

Budgeted Income Statement For the Year Ending December 31, 2006 Elite Accessories Inc. Budgeted Income Statement For the Year Ending December 31, 2006 Revenue from sales (slide 23) $13,336,000 Cost of goods sold (slide 40) 9,047,780 Gross profit $ 4,288,220 Selling & administrative expenses: Selling expenses (slide 41) $1,190,000 Administrative expenses (slide 41) 695,000 Total sell. & Admin. Expenses 1,885,000 Income from operations $ 2,403,220 Other income: Interest revenue $ 98,000 Other expense: Interest expense 90,000 8,000 Income before income tax $ 2,411,220 Income tax 600,000 Net income $ 1,811,220

Budgeted Balance Sheet

The cash budget is one of the most important elements of the budgeted balance sheet. We’ll begin with a schedule of collection from sales.

Schedule of Collections from Sales Elite Accessories Inc. Schedule of Collections from Sales For the Three Months Ending March 31, 2006 January February March Receipts from cash sales: Cash sales (10%)(see Note A)……………………... $108,000 $ 124,000 $ 97,000 Note A: $108,000 = $1,080,000 x 10% $124,000 = $1,240,000 x 10% $ 97,000 = $ 970,000 x 10%

Schedule of Collections from Sales Elite Accessories Inc. Schedule of Collections from Sales For the Three Months Ending March 31, 2006 January February March Receipts from cash sales: Cash sales (10%)(see Note A)……………………... $108,000 $ 124,000 $ 97,000 Receipts from sales on account: Collections from prior month’s sales (40%)(see Note B)……. $370,000 $ 388,800 $446,400 Note B: $370,000, given as January 1, 2006 Accounts Receivable balance $388,800 = $1,080,000 x 90% x 40% $446,400 = $1,240,000 x 90% x 40%

Schedule of Collections from Sales Elite Accessories Inc. Schedule of Collections from Sales For the Three Months Ending March 31, 2006 January February March Receipts from cash sales: Cash sales (10%)(see Note A)……………………... $108,000 $ 124,000 $ 97,000 Receipts from sales on account: Collections from prior month’s sales (40%)(see Note B)……. $370,000 $ 388,800 $446,400 Collections from current month’s sales (60%)(see Note C)…………………………… 583,200 669,600 523,800 Note C: $583,200 = $1,080,000 x 90% x 60% $669,600 = $1,240,000 x 90% x 60% $523,800 = $ 970,000 x 90% x 60%

Schedule of Collections from Sales Elite Accessories Inc. Schedule of Collections from Sales For the Three Months Ending March 31, 2006 January February March Receipts from cash sales: Cash sales (10%)(see Note A)……………………... $108,000 $ 124,000 $ 97,000 Receipts from sales on account: Collections from prior month’s sales (40%)(see Note B)……. $370,000 $ 388,800 $446,400 Collections from current month’s sales (60%)(see Note C)…………………………… 583,200 669,600 523,800 Total receipts from sales on account……………………... $953,200 $1,058,400 $970,200

Schedule of Payments for Manufacturing Costs Elite Accessories Inc. Schedule of Payments for Manufacturing Costs For the Three Months Ending March 31, 2006 January February March Payment of prior month’s manufacturing costs (25%) (see Note A)………………… $190,000 $204,000 $189,000 Note A: $190,000, given as January 1, 2006 Accounts Payable balance $204,000 = ($840,000 –$24,000) x 25% $189,000 = ($780,000 – $24,000) x 75%

Schedule of Payments for Manufacturing Costs Elite Accessories Inc. Schedule of Payments for Manufacturing Costs For the Three Months Ending March 31, 2006 January February March Payment of prior month’s manufacturing costs (25%) (see Note A)………………… $190,000 $204,000 $189,000 Payment of current month’s manufacturing costs (75%) (see Note B)…………………. 612,000 567,000 591,000 Note B: $612,000 = ($840,000 – $24,000) x 75% $567,000 = ($780,000 – $24,000) x 75% $591,000 = ($812,000 – $24,000) x 75%

Schedule of Payments for Manufacturing Costs Elite Accessories Inc. Schedule of Payments for Manufacturing Costs For the Three Months Ending March 31, 2006 January February March Payment of prior month’s manufacturing costs (25%) (see Note A)………………… $190,000 $204,000 $189,000 Payment of current month’s manufacturing costs (75%) (see Note B)…………………. 612,000 567,000 591,000 Total payments………………. $802,000 $771,000 $780,000

For the Three Months Ending March 31, 2006 Elite Accessories Inc. Cash Budget For the Three Months Ending March 31, 2006 January February March Estimated cash receipts: Cash sales (Slide 45)………….. $ 108,000 $ 124,000 $ 97,000 Collections of accounts receivable (Slide 48)………... 953,200 1,058,400 970,200 Interest revenue………………... — — 24,500 Total cash receipts……………. $1,061,200 $1,182,400 $1,091,700

For the Three Months Ending March 31, 2006 Elite Accessories Inc. Cash Budget For the Three Months Ending March 31, 2006 January February March Estimated cash receipts: Cash sales (Slide 45)………….. $ 108,000 $ 124,000 $ 97,000 Collections of accounts receivable (Slide 48)………... 953,200 1,058,400 970,200 Interest revenue………………... — — 24,500 Total cash receipts……………. $1,061,200 $1,182,400 $1,091,700 Estimated cash payments for: Manufacturing costs (Slide 51).. $ 802,000 $ 771,000 $ 780,000 Selling and administrative expenses……………………… 160,000 165,000 145,000 Capital additions 274,000 Interest expense 22,500 Income taxes 150,000

For the Three Months Ending March 31, 2006 Elite Accessories Inc. Cash Budget For the Three Months Ending March 31, 2006 January February March Estimated cash receipts: Cash sales (Slide 45)………….. $ 108,000 $ 124,000 $ 97,000 Collections of accounts receivable (Slide 48)………... 953,200 1,058,400 970,200 Interest revenue………………... — — 24,500 Total cash receipts……………. $1,061,200 $1,182,400 $1,091,700 Estimated cash payments for: Manufacturing costs (Slide 51).. $ 802,000 $ 771,000 $ 780,000 Selling and administrative expenses……………………… 160,000 165,000 145,000 Capital additions 274,000 Interest expense 22,500 Income taxes 150,000 Total cash payments…………. $ 984,500 $1,210,000 $1,075,000

For the Three Months Ending March 31, 2006 Elite Accessories Inc. Cash Budget For the Three Months Ending March 31, 2006 January February March Estimated cash receipts: Cash sales (Slide 45)………….. $ 108,000 $ 124,000 $ 97,000 Collections of accounts receivable (Slide 48)………... 953,200 1,058,400 970,200 Capital additions 274,000 Interest expense……………….. 22,500 Income taxes…………………... 150,000 Total cash payments…………. $ 984,500 $1,210,000 $1,075,000 Cash increase (decrease)…………. $ 76,700 $ (27,600) $ 16,700 Cash balance at beginning of month 280,000 356,700 329,100 Cash balance at end of month……. $ 356,700 $ 329,100 $ 345,800 Minimum cash balance…………… 340,000 340,000 340,000 Excess (deficiency)………………. $ 16,700 $ (10,900) $ 5,800

Chapter 21 The End